Any startup, be it a small family business or an endeavor into Silicon Valley, needs funding. They also have an understandable desire to raise their needed capital with as few legal hurdles as possible.
The problem is that startup fundraising is a particularly regulated process that requires companies to be in compliance with the Securities Exchange Commission (SEC) of the United States. This means registering and reporting all offerings and sales of any securities with the SEC.
The reality is that most startup companies in their early phases simply do not have the legal resources necessary to satisfy the SEC reporting and registration requirements. Because of this, both Congress and the SEC have set in place certain exemptions from the registration provision.
Regulation D Exemptions for Startups
The use of Regulation D (Reg D) is among the most common mechanisms for small companies and startups to raise money by way of investors without the requirement to register with the SEC. It is through Reg D offerings that startups may raise capital quickly by selling equity or debt securities while at the same time bypassing the complex SEC filing process or the costs involved with public offerings.
Private placement exemptions may be structured in a number of ways and many are arranged to be in compliance with provisions found within Regulation D of the Securities Act of 1933. Varying furthermore by the amount of capital desired and even the kind of investors petitioned.
For most start-ups, Regulation D carries rules granting exemption status:
The Relatively recently “bigger and better” Rule 504, which came into effect in January 2017 and repealed Rule 505 in May 2017, allows a privately held company the ability to raise up to $5 million throughout a 12 month time period. Securities are available to an unlimited number of investors and the exemption requires no explicit disclosure data to satisfy the exemption. The adoption of the final rules with regard to Rule 504 serves to eliminate the need for Rule 505, whose only historical advantage was its higher maximum offering limit. The Rule 504 offering exemption does not, however, preempt state blue sky laws as does Rule 506 of Regulation D. Thus, an issuer utilizing Rule 504 needs to ensure that an appropriate state securities law exemption is available.
The advantages of rule 506 are the company doesn’t have to register for any state-level exemption, offerings may only be made to accredited investors, and there is no limit on the amount of capital that may be raised.
- Rule 506(b) – Private Fundraising
The most commonly used exemption, 506(b) allows a company to raise capital without public announcement. Usually, this means a company may offer securities to buyers a company already knows or believes to be accredited.
- Rule 506(c) – Public Fundraising
Allows a company to raise capital through public channels so long as the company makes an honest effort to only accept accredited investors. The company is not required to have a pre-existing relationship with investors.
Regulation D exemptions are intended to support small startup companies with finite funding. Consider Reg D if you are or plan to run a startup company, are in need of fast and less restrictive funding, and you wish to avoid the trouble and costs of offering your securities to the public.
Unparalleled Startup Structuring & Financing Attorneys
Budding entrepreneurs and startups must understand the regulatory world before they begin their journey to raise capital. There are many legal nuances involved and the structuring of offerings may lead to significant changes to a business over time.
The attorneys at Kundani Chang Khinda & Wilson LLP will partner with you as you build your business from the ground up. From startup structuring to offerings of equity and debt securities, our legal team has the experience and insight to support your business aspirations both now and in the future. Connect with your trusted advisors today to schedule a free consultation.